Tesco is seeking a new deal with dairy farmers after a chaotic summer for the agriculture industry during which protesters paraded cows around a supermarket.

The retailer has written to farmers outlining terms that include reviewing the price it pays every three months rather than every six and ranking suppliers based on their performance, with the worst potentially losing their deals.

Matt Simister, Tesco’s commercial director for fresh food and commodities, says in the letter that the agreement is “progressive, fit for the future and, importantly, one that we can continue to be proud of for many years to come”.

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The letter is likely to be broadly welcomed by farmers because Tesco stands by its commitment to pay a price for milk based on the cost of production.

In the letter, Simister says: “We believe that working closely with our producers through an independent cost tracker continues to be the fairest and most sustainable way that we can deliver the best quality milk for our customers, whilst maintaining the highest standards of animal welfare.”

In August the National Farmers Union said dairy producers were facing a “state of emergency” after the price they were paid for milk fell by a quarter in a year. Aldi, Lidl, Asda and Morrisons were targeted by protesters because they paid less for milk than Tesco and Sainsbury’s and did not base prices on the cost of production. Cows were paraded through the aisles of an Asda store in Stafford.

Tesco launched a review of its agreement with farmers, called the Tesco Sustainable Dairy Group (TSDG), as as part of a drive by the new chief executive, Dave Lewis, to simplify the company’s relationships with suppliers. The new terms will be introduced from 1 February next year.

Tesco said updating the price of milk every three months instead of every half-year would allow the price to “better reflect actual on-farm costs such as feed, fertiliser, and fuel”.

Tesco will also remove a clause that allowed it to shift the price it paid for milk to the wider market price if it was significantly lower. In return, the supermarket wants all farms to submit their accounts to Proma, an independent consultancy, so that it can properly analyse the price to pay for milk. An incentive of 0.5p per litre for farmers that submitted their accounts will also be removed.

Tesco will rank its suppliers based on milk quality, animal welfare and environmental standards. The top 5% farmers according to this ranking will be rewarded with an extra order of 100,000 litres of milk a year, while the bottom 5% will be given three months to meet Tesco’s standards or be axed as suppliers.

Simister said the ranking system was designed to help make British farming more competitive. He said: “We believe if we are going to make British agriculture more competitive we need a culture of continuous improvement through the supply chain.”

Simister said the agreement was “more sophisticated”, and he acknowledged that some farmers had endured an “incredibly tough” summer. “This is not a PR gimmick, it is economically sustainable system that will be there for the long-term,” he said. “We have a duty that our supply chain is healthy, well-invested and sustainable.”

The review was conducted by Tesco bosses along with input from leading dairy processors such as Muller Wiseman and farmers. About 650 farmers are part of the TSDG, making it the biggest farming group in the country.